The SITREP

In the "decades" timeframe, the current Secular Bull Market could turn out to be among the shorter Secular Bull markets on record.  This is because of the long-term valuation of the market which, after only eight years, has reached the upper end of its normal range. 

The long-term valuation of the market is commonly measured by the Cyclically Adjusted Price to Earnings ratio, or “CAPE”, which smooths out shorter-term earnings swings in order to get a longer-term assessment of market valuation.  A CAPE level of 30 is considered to be the upper end of the normal range, and the level at which further PE-ratio expansion comes to a halt (meaning that increases in market prices only occur in a general response to earnings increases, instead of rising “just because”). 

Of course, a “mania” could come along and drive prices higher – much higher, even – and for some years to come.  Manias occur when valuation no longer seems to matter, and caution is thrown completely to the wind as buyers rush in to buy first and ask questions later.  Two manias in the last century – the 1920’s “Roaring Twenties” and the 1990’s “Tech Bubble” – show that the sky is the limit when common sense is overcome by a blind desire to buy.  But, of course, the piper must be paid and the following decade or two are spent in Secular Bear Markets, giving most or all of the mania gains back. 

See Fig. 1 for the 100-year view of Secular Bulls and Bears.  The CAPE is now at 33.02, up from the prior week’s 32.16, and exceeds the level reached at the pre-crash high in October, 2007.  This value is in the lower end of the “mania” range.  Since 1881, the average annual return for all ten year periods that began with a CAPE around this level have been in the 0% - 3%/yr. range.  (see Fig. 2).

In the big picture:

The “big picture” is the months-to-years timeframe – the timeframe in which Cyclical Bulls and Bears operate.  The U.S. Bull-Bear Indicator (see Fig. 3) is in Cyclical Bull territory at 71.77, up from the prior week’s 69.90.

In the intermediate and Shorter-term picture:

The Shorter-term (weeks to months) Indicator (see Fig. 4) turned positive on April 3rd.  The indicator ended the week at 20, up from the prior week’s 17.  Separately, the Intermediate-term Quarterly Trend Indicator - based on domestic and international stock trend status at the start of each quarter – was negative entering April, indicating poor prospects for equities in the second quarter of 2018.

 Timeframe summary:

In the Secular (years to decades) timeframe (Figs. 1 & 2), the long-term valuation of the market is simply too high to sustain rip-roaring multi-year returns – but the market has entered the low end of the “mania” range, and all bets are off in a mania.  The only thing certain in a mania is that it will end badly…someday.  The Bull-Bear Indicator (months to years) is positive (Fig. 3), indicating a potential uptrend in the longer timeframe.  In the intermediate timeframe, the Quarterly Trend Indicator (months to quarters) is negative for Q2, and the shorter (weeks to months) timeframe (Fig. 4) is positive.  Therefore, with two indicators positive and one negative, the U.S. equity markets are rated as Neutral.

In the markets:

U.S. Markets:  U.S. stocks recorded solid gains for the week, with the Nasdaq Composite and S&P 400 mid cap indexes reaching new highs, and the large cap S&P 500 index hitting its best level since early March.  The Dow Jones Industrial Average surged almost 700 points to close at 25,316, a gain of 2.8%.  The technology-heavy NASDAQ Composite Index rose for a third consecutive week, rising 1.2% to close at 7,645.  By market cap, mid cap’s led the way with a 2.2% gain for the S&P 400, while the large cap S&P 500 added 1.6%, and the small cap Russell 2000 rose 1.5%. 

International Markets:  Canada’s TSX rebounded from last week’s loss by gaining 1.0%.  The United Kingdom’s FTSE was off -0.3%, for a third consecutive down week.  On Europe’s mainland, France’s CAC 40 finished down ‑0.3%, Germany DAX added 0.3%, and Italy’s Milan FTSE dropped -3.4% on political turmoil.  In Asia, China’s Shanghai Composite finished down -0.3%, while Japan’s Nikkei retraced all of last week’s loss and closed up 2.4%.  As grouped by Morgan Stanley Capital International, developed markets finished the week up 0.6%, while emerging markets were unchanged.

Commodities:  Precious metals regained a bit of their shine.  Gold finished the week up 0.26%, closing at $1302.70 an ounce.  Silver, which often trades similarly to Gold but with more volatility, also finished the week up 1.82% closing at $16.74 an ounce.  The industrial metal copper, seen as a barometer of worldwide economic health due to its variety of uses, surged 6.5% last week.  Oil was down for a third consecutive week, but off only -0.1%.  West Texas Intermediate crude oil finished the week at $65.74 per barrel.

U.S. Economic News:  The number of people seeking new unemployment benefits fell slightly last week, keeping the rate of layoffs near a 50-year low.  The Labor Department reported that initial claims for unemployment benefits fell by 1,000 to 222,000 lower than economists’ forecasts for a reading of 225,000.  The less volatile monthly average of new claims rose by 2,750 to 225,500.  Overall, the unemployment rate remains extremely low in every state, and there’s no indication if it rising anytime soon.  The number of people already collecting unemployment benefits, known as continuing claims, increased by 21,000 to 1.75 million.  That number is also near its lowest level in decades.

The number of job openings rose to 6.7 million in April, the Labor Department reported this week in its “JOLTS” report (officially titled the Job Openings and Labor Turnover Survey).  The reading was its highest in over 18 years.  In the report, there were more job openings for durable-goods manufacturing and in the information sector, while the number of jobs in finance and insurance declined.  The “quit rate”, watched closely by the Federal Reserve (which assumes that people would only quit a job for a more lucrative one), remained at just 2.3%.  Companies continue to complain about the quality of available workers, but firms haven’t aggressively bid up wages to recruit the best workers.

New orders for U.S.-manufactured goods fell more than expected in April, as demand for transportation equipment and machinery declined.  The Commerce Department reported factory goods orders decreased 0.8%, missing economists’ forecast of just a 0.5% decline.  The details of the report revealed that the decline was predominantly due to a decline in orders for commercial aircraft.  Orders for non-durable goods were actually up slightly.  Overall, the underlying trend continued to suggest strong momentum in the manufacturing sector.  From the same time last year orders were up 8.3%, and last week’s survey by the Institute for Supply Management (ISM) showed sentiment among manufacturers perking up in May amid a surge in new orders. 

In the services sector, the ISM survey of businesses which employ most Americans rose to a near 13-year high of 58.6 last month, another sign the economy is speeding up again.  Readings over 50 are viewed as positive for the economy, while anything over 55 is considered exceptional.  In the details, production, new orders, and employment, while already at high levels soared even higher.  ISM’s spokesman Anthony Nieves stated, “The majority of respondents are optimistic about business conditions and the overall economy.”  Yet he added that “there continues to be concerns about the uncertainty surrounding tariffs, trade agreements and the impact on cost of goods sold.” 

The trade deficit fell to a 7-month low of just $46.2 billion dollars as exports edged up 0.3% to a record $211.2 billion, the Commerce Department reported.  The trade deficit shrank 2.1% in April as the United States exported the most domestically-produced petroleum in five years, along with more soybeans and corn.  Exports of commercial aircraft, a very volatile category that jumps around from month to month, fell sharply in April, while imports slipped by 0.2% to $257.4 billion.  The U.S. trade deficit with China fell sharply due to a drop in imports, but analysts noted that the decline was unrelated to pending tariffs on billions in Chinese goods.  Gregory Daco, chief U.S. economist at Oxford Economics wrote in a note to clients, “The big question going forward is how the trade ledger is affected by the Trump administration’s recent tariff decisions and reciprocal retaliation by the EU, Canada and Mexico, not to mention the recent strengthening of the dollar and jump in oil prices.”  For now he doesn’t see trade tensions posing a significant threat to the U.S. economy.

President Donald Trump is “very seriously contemplating” separate trade negotiations with Canada and Mexico, White House economic advisor Larry Kudlow said this week.  Kudlow said that the President’s stated preference is to negotiate with Mexico and Canada separately.  It was unclear whether pursuing bilateral trade agreements with the two countries would effectively end the trilateral North American Free Trade Agreement (NAFTA), which has been in place for more than 20 years.  A Canadian government official pointed out this was not the first time the Trump administration has suggested a bilateral, rather than multilateral, approach.  Canada is the United States’ second largest trading partner.  The International Monetary Fund estimates failure to reach a new NAFTA agreement could reduce long-run Canadian real gross domestic product by 0.4% relative to its baseline forecast.

International Economic News:  A deputy governor at the Bank of England who had earlier stated the UK’s economic weakness in the first quarter was due predominantly to a snow storm dubbed ‘the Beast from the East’ is being vindicated by recent economic data.  Speaking at a conference in London, Dave Ramsden, deputy governor for markets and banking, argued that the most recent surveys and data supported his view.  “The data we have had so far suggests our interpretation of the slowdown in Q1 as temporary looks to be being borne out,” he told the Barclays Inflation Conference.  “Consumer confidence and consumer credit both picked up in the latest data, as did retail sales and several business surveys. That included the latest services output balance, representing 80 per cent of the economy.  So far at least our May judgement looks on track.”

A memo written by three renowned economists who worked on French President Emmanuel Macron’s campaign program, noted that Macron’s economic policy is widely viewed as favoring the rich and must change to address inequalities.  The confidential memo sent to Macron, which ended up plastered across the newspaper Le Monde’s front page shortly thereafter, said the policy was failing to convince “even the most ardent supporters”.  The criticism is the latest sign of the trouble created by Macron’s economic reforms among the center-left supporters who propelled him to power last year.  None of the authors (Jean Pisani-Ferry, the Sciences Po Paris university professor who coordinated Macron’s economic program, Philippe Martin, a former Macron adviser who heads France’s Council of Economic Analysis and Philippe Aghion of the elite College de France) would comment to the media following the memo’s release. 

Industrial production in Germany fell for the fourth month in a row, a run of poor economic news from Europe’s economic powerhouse.  The 1% drop in factory output, combined with a surprising decline in factory orders reported earlier this week, indicates a slower pace of expansion is now Germany’s new normal.  A separate report showed that exports fell 0.3% in April.  Germany’s Minister for Economic Affairs and Energy Peter Altmaier was quick to deliver a statement saying that there was no reason to believe Germany’s long economic upswing was at an end, adding that protectionism and high tariffs help no one.

Italian government bonds slid and yields surged last week as a constitutional crisis appeared to be unfolding in Italy when President Sergio Mattarella rejected a finance minister that had been critical of the euro.  While markets calmed somewhat after the coalition parties altered their proposals to form a government, investors worried that Italy’s plans to challenge European Union fiscal rules could lead to further turmoil in the future.  Italy is the first major EU member to be governed by a populist coalition as the anti-establishment Five Star Movement and the far-right League party captured a combined parliamentary majority in March elections.  Neither of the parties supports Italy’s membership in the Eurozone, but for vastly different reasons.

Inflation in China remained subdued, with consumer price growth continuing to be mild and factory prices edging up only slightly in May.  China’s National Bureau of Statistics reported that China’s main gauge of inflation, its consumer price index, rose just 1.8% year-over-year in May.  Statistician Sheng Guoqing attributed most of the rise to carry-over effects with new price-rising factors contributing just 0.4 percentage points.  Lower food prices were the main factor in the decline, with non-food prices remaining largely flat.  Liu Xuezhi, a senior researcher with the Bank of Communications, said the core CPI excluding food and energy edged down to 1.9% in May from 2.0% in April, the same as the January figure and the lowest in nearly 15 months.  "Real inflation has been mild, and there is no obvious inflationary pressure thanks to the performance of the core CPI and weak new price-rising factors," Liu said.

Japan’s Gross Domestic Product shrank 0.6% on an annualized basis in the first quarter of the year, as a weaker reading of private consumption offset a stronger one for capital investment.  However, analysts and government officials were quick to insist that Japan’s economic recovery isn’t over just yet.  Tomo Kinoshita, chief market economist for Nomura Securities, said the downturn was partly caused by soft global demand and “had probably passed”.  "Looking forward, we are more optimistic about the U.S. and EU, and that should help Japan’s exports regain momentum, and that should drive the overall economy," Kinoshita said.  Japan’s economy minister Toshimitsu Motegi told reporters, “The negative growth comes after eight straight quarters of positive economic growth … so we think the economy is still modestly recovering.”

Finally:  Interest in buying gold is often viewed as a barometer of fear and financial stress in the markets and world economies.  Historically, analysts have used surveys, buying vs selling patterns, and interviews to gauge such interest.  In this, the internet age, another tool has emerged: Google search statistics. 

Google’s Search Trends feature is a fast and anonymous way to determine the level of demand for gold by examining the popularity of several different phrases, such as ‘buy gold’, to measure demand.  Last month saw the fewest Google searches for “buy gold” since July of 2007 – right before the global financial crisis. 

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(sources: all index return data from Yahoo Finance; Reuters, Barron’s, Wall St Journal, Bloomberg.com, ft.com, guggenheimpartners.com, zerohedge.com, ritholtz.com, markit.com, financialpost.com, Eurostat, Statistics Canada, Yahoo! Finance, stocksandnews.com,  marketwatch.com,  wantchinatimes.com, BBC, 361capital.com, pensionpartners.com, cnbc.com, FactSet; Figs 1-5 source W E Sherman & Co, LLC)

The ranking relationship (shown in Fig. 5) between the defensive SHUT sectors ("S"=Staples [a.k.a. consumer non-cyclical], "H"=Healthcare, "U"=Utilities and "T"=Telecom) and the offensive DIME sectors ("D"=Discretionary [a.k.a. Consumer Cyclical], "I"=Industrial, "M"=Materials, "E"=Energy), is one way to gauge institutional investor sentiment in the market.  The average ranking of Defensive SHUT sectors fell to 23.25 from the prior week’s 22.75, while the average ranking of Offensive DIME sectors rose slightly to 10.50 from the prior week’s 10.75.  The Offensive DIME sectors maintained a sizeable lead over the Defensive SHUT sectors.  Note: these are “ranks”, not “scores”, so smaller numbers are higher ranks and larger numbers are lower ranks.